Paul A. Volcker learned integrity at home. He was born on September 5, 1927, in Cape May, New Jersey, to Alma and Paul A. Volcker Sr. In 1930 his family moved to the northern part of the Garden State when Paul Sr. became the town manager of Teaneck, a small suburban community five miles west of New York City. Volcker Sr., a civil engineering graduate of Rensselaer Polytechnic Institute in upstate New York, rescued the town from the Great Depression and managed its affairs for twenty years, creating a zoning system, a paid fire department, and civil service for township employees.1 “The population doubled while my dad was manager,” Volcker recalls. “I’ve always been proud of his success.”2
A quote from George Washington hanging on the wall in his father’s office burrowed into young Paul’s brain: “Do not suffer your good nature … to say yes when you ought to say no; remember that it is a public not a private cause that is to be injured or benefited by your choice.”3 Paul Volcker Sr. lived by those words, going to extreme measures to avoid even the hint of impropriety, no matter what the consequence, sometimes at young Paul’s expense.
Dick Rodda, the Teaneck recreation director, had hired fifteen high school students, including Buddy Volcker, as Paul was called, to work part-time as safety monitors after a snowstorm. When Paul Sr. found out, he called Dick to his office and said, “I want Buddy off the payroll … I want you to fire him.” When Dick protested, Paul Sr. said, “If you won’t fire him I’ll find a new recreation superintendent who will.” Dick Rodda did as he was told.4
Paul watched his father purge the emotion from every decision, deliberating like the pipe smoker he was. “If someone came by on a Monday with a request he had not considered before, he would say, ‘Come back on Thursday and I’ll have an answer.’ He almost turned procrastination into a virtue. He was thoughtful and scrupulous, weighing every option in the process. I learned never to make a decision before its time … for better and worse.”5
As far back as he can remember, Paul craved his family’s approval. It began when he was five, in kindergarten, the day he brought home his first evaluation from Miss Constance Palmer. Maybe every boy thinks that his first teacher is beautiful, but he insists she really was. “I remember when she led me by the hand into the circle with the other kids. I liked the attention until she added a note to my report: ‘Paul does not take part in group discussion and does not play well with others.’”6 Those comments worried his parents, especially when his sisters chimed in, “And when Buddy plays with his friends they hardly ever speak.” Their concern only deepened Buddy’s natural reticence.
Paul’s reserve continued as he grew older, creating a serious handicap with the opposite sex. During high school, he was too self-conscious to ask a girl out on a date. But his shyness also had an upside, blossoming into self-reliance. He became a Brooklyn Dodgers fan simply because all his friends rooted for the Yankees or the Giants, who played just a few miles away, across the George Washington Bridge. They considered Brooklyn a foreign country, where people spoke a different language. Paul found that he liked being a contrarian.
A curious blend of insecurity and self-confidence emerged in young Paul. At times the insecurity dominated, especially when it came to report cards. He worried about his father’s signature on the card. When he did well, his father would embellish the V in his name, as though he was signing the Declaration of Independence; when his grades fell short, a simple PAV flowed from his father’s pen. “I always wanted the fancy ‘Volcker’ on the back of the card but did not get it often enough.”7
Paul Volcker Sr. graded like a headmaster: no nonsense … and no hugs or kisses either. The tension rose when Paul applied to college in the spring of 1945. His father suggested his alma mater, Rensselaer. Paul decided to apply to Princeton, just to see if he could make it. The application form itself was intimidating—it felt like parchment when he filled it out—but two weeks later he was accepted. His father tried to persuade him not to go, with a warning: “Prep school students will do better at Princeton than a graduate from Teaneck public high. You’ll find out that you’re not so smart.”8
Paul decided to take a chance to prove a point.
Uncle Sam almost accomplished what Paul Sr. failed to do. A formal invitation arrived in April 1945, soon after the Princeton acceptance, requesting that Paul visit his local draft board for a physical exam. The war was winding down in Europe, and Paul had been unhappy when the captain of the Teaneck varsity jumped the gun and volunteered. “We were having a championship season on the basketball court, and that derailed our prospects. When I went for the physical I thought about crouching down so that I would not exceed the maximum acceptable six-foot, six-inch height. I didn’t try very hard and was rejected with a physical deferment … I’ve always regretted that decision, wondering whether I let myself and my country down.”9
Volcker concentrated on economics and basketball at Princeton between 1945 and 1949. Much to his disappointment, he was far better at economics, despite his elongated frame. “I never got along with the coach,” Volcker complains, sounding like a benchwarmer covering up for bad footwork or bad hands, “so I didn’t play much.”10 Perhaps that is why he found refuge with Princeton’s two famous German-born economists, Friedrich Lutz and Oskar Morgenstern, who had come to America after Hitler’s rise to power. Lutz taught Volcker about money and banking, his lifelong preoccupation; Morgenstern taught him to worry, his lifelong compulsion.
Morgenstern is best known for his book Theory of Games and Economic Behavior, published in 1944 with John von Neumann, one of the most famous mathematicians of the twentieth century.11 Volcker never studied much game theory, a formal approach to strategic decision making, beyond what Morgenstern had discussed in class, but the professor left his mark by turning Paul into a professional skeptic.
Morgenstern worried about the relevance of economics. He said that “unless [economics] offers a contribution to the mastering of practical life … it is but an intellectual plaything … similar to chess.”12 Morgenstern probably disliked chess because the Russians dominated it, but he really did want economics to be more than just a game and warned that “insufficiency of data is in great part responsible for the fact that economic policy is so often lacking in rationality.”13 Back then, his colleagues spent most of their time thinking rather than doing.
Oskar Morgenstern would soon write On the Accuracy of Economic Observations, published in 1950, warning against the mistreatment of economic data. He did not mince words: “It [is] grotesque to see the New York Times, for example, often reporting on its front page that ‘consumer prices’ have ‘risen’ or ‘fallen’ by 1/10 of 1 percent without any qualifying word about the significance of this change in a mere index of doubtful validity.”14
Volcker recalls Morgenstern’s shocking example of data on international gold movements, which often made front-page headlines throughout the world. “Oskar showed numerous years in which Britain’s reported gold imports from the United States differed substantially from America’s reported gold exports to the U.K. This logical inconsistency made a mockery of further analysis.”15
Volcker spent most of his days at Princeton reading and playing basketball, not necessarily in that order. “I devoured Friedrich Hayek’s Road to Serfdom.16 His defense of free enterprise made me wary of government intervention—and proud to be an American, even though Hayek warned against our creeping socialism. As for coursework, I listened to what the professors had to say and found that I could get As by repeating their views, almost verbatim, on the exams.”17
Princeton dealt with students who were too smart for their own good by requiring a thesis for graduation—a lengthy tome on some weighty subject that could not be written while shooting baskets. Paul responded to the looming deadline by ignoring the problem. With less than a semester left, he had done nothing.
According to Volcker, Professor Frank Graham, assigned as his thesis adviser, saved him. “I decided to write on Federal Reserve policy after World War II. It turned out more complicated than I had anticipated. Professor Graham gave me great advice: to write first and edit later. I would submit a handwritten chapter on yellow legal-size paper on a Friday afternoon, and he would return it the following Monday with detailed comments and corrections. I was too embarrassed not to push ahead.”18
Graham, an expert in international trade, flattered Volcker with his attention. Paul had always been too shy and insecure to meet with professors. “I thought they did not have time for me.”19 Graham pushed his young protégé, hoping he would pursue graduate study in economics, and Paul ultimately submitted his thesis with a week to spare, graduating summa cum laude in the process. Volcker would follow this “procrastinate and flourish strategy” throughout his professional career. “I found that it worked, so I never changed.” And then he adds, “Besides, it gave me time to think and to get it right.”20
Volcker continued his studies in economics while attending the Graduate School of Public Administration at Harvard in 1950 and 1951, listening to lectures by, among others, Alvin Hansen, the foremost expositor of the new Keynesian theory of activist government intervention. “Hansen was a great teacher,” Volcker recalls, “but I had cut my teeth in economics as an undergraduate at Princeton. I was very skeptical.”21
Volcker received his master’s degree from Harvard in 1951 and then left for the London School of Economics, armed with a Rotary Club fellowship to write his doctoral dissertation. Paul spent most of his time traveling through Europe. “I found a girlfriend who kept me busy. And when time got short, there was no Professor Graham to save my hide. I still feel bad about not completing my degree. I had also disappointed my father, who had saved the clipping from the local newspaper when I received the fellowship. He was an active member of the Rotary Club. I screwed up a good opportunity.”22
Paul redeemed himself by pursuing a career in public service, like his father. Paul Sr. helped by getting his son an interview at the Federal Reserve Bank of New York. The New York Fed is the most important of the twelve regional Federal Reserve Banks that serve as branches of America’s central bank, headed by the Federal Reserve Board in Washington, D.C. The New York Bank, a fortress-like building in Lower Manhattan, serves as the observation post of the Federal Reserve System, located two blocks from the New York Stock Exchange and within walking distance of the numerous government bond dealers that buy and sell securities with the Federal Reserve every day.
Robert Roosa, vice president of the Research Department at the Federal Reserve Bank of New York, molded Volcker’s thinking after he was hired as an economist in 1952. Roosa drafted Volcker to help produce Federal Reserve Operations in the Money and Government Securities Markets, a little red booklet (107 pages long) that instructed a generation of policy makers about central bank strategy.23 Illinois senator Paul Douglas, chairman of the congressional Joint Economic Committee, described Roosa as “probably the foremost authority on the technical operation of the money market in Government securities.”24 He had become an expert after transferring in 1954 from the New York Bank’s Research Department to the open market desk, where traders bought and sold securities for the Federal Reserve System.
Roosa’s move to the practical side of the Federal Reserve was unprecedented. Economists were considered too cerebral for the instinct-driven trading business, and in the mid-1950s they were segregated in research, barely a notch above the accountants. Roosa broke further ground by putting the twenty-seven-year-old Volcker in the trading room—as an observer, of course. The experience married theory and practice in Volcker’s brain and altered the trajectory of his career. If Oskar Morgenstern had convinced Paul that data were essential, but fraught with error, then Robert Roosa gave him the opportunity to examine data under a microscope—data from the heart of Wall Street.
Volcker encountered a new world when he entered the trading room at the New York Fed. Unlike modern trading facilities, decorated with computer terminals and multicolored electronic displays, the 1955 model carried the stark imprint of a black-and-white movie production. A U-shaped desk, equipped with telephone consoles for each trader, filled the entire space, while a large chalkboard hanging on the wall at the open end of the U recorded the relevant statistics, much like a primitive scoreboard at a baseball game. Prices of government bonds, which were frozen in print in the Research Department, now danced in Volcker’s head during phone conversations with Wall Street’s bond dealers. Shorthand words for buying and selling could make the conversations sound like gibberish. It took a practiced ear to decipher the meaning of “9 bid, offered at 10, 100 by 100,” but Paul caught on quickly and reveled in the details, feeling as though he had been initiated into a secret fraternity.25
On Wednesdays, when commercial banks had to meet their required reserves prescribed by the Federal Reserve, Volcker would work past midnight on his weekly report for the Federal Reserve’s Open Market Committee. The committee, referred to as the FOMC, is the central bank’s decision-making body. It consists of the seven members of the Federal Reserve Board, appointed by the president of the United States, plus five of the twelve regional Reserve Bank presidents, who serve on the FOMC on a rotating basis.
The FOMC was run by the then chairman of the Federal Reserve Board, William McChesney Martin, who had been appointed by President Harry Truman in 1951 and would serve until 1970. Martin was a former banker, just like everyone else on the board in the mid-1950s. Perhaps the economy was a lot simpler in those days, but the absence of economists bore the chairman’s imprint.26 Martin thought economists’ forecasts rivaled the accuracy of fortune teller predictions, probably an insult to the fortune tellers: “If the decision were mine alone, I would dispense with [that] kind of analysis.”27 He also felt that economists lacked the practical experience needed of central bankers.
With Martin at the helm, it is not surprising that economist Paul Volcker failed to make the distribution list of those permitted to read the weekly report that he wrote. His wife, Barbara, taunted him: “You can write it but can’t read it. What’s wrong with these people?”28
Barbara, a pretty woman with short dark hair that she denigrated as mousey, had majored in irreverence at Pembroke College, part of Brown University. She had been married to Paul for less than two years at the time and did not appreciate his midnight scribbling. Paul knew that she was right about the Fed, as she was about most things. The rigid bureaucracy would wear him down. But he also knew that his memoranda to the FOMC mattered, even though he was a mere economist, because they came from his observer status on the open market desk. He had the credibility of an embedded reporter on the front lines. He even went to an FOMC meeting as Roosa’s scribe and recalls thinking, “It would be nice to sit around the table as a member of the board.”29
Volcker’s memos bristled with facts and figures: how many securities were bought or sold, at what prices, who was buying and who was selling, and perhaps most important, what the dealers expected interest rates to do in the near term. Dealers profit by anticipating whether interest rates will decrease or increase, whether bond prices rise or fall. They make money buying before prices jump and selling before they drop. Volcker paid attention to the details, especially the link between expectations and behavior, and recognized the importance of fitting the pieces together, much as he had in his boyhood hobby of building model airplanes. Every plane, made from balsa wood and paper, with a rubber band to crank the propeller, was perfectly balanced, ready to fly.
The Fed’s trading room was a bridge between economic research and the real world, and Volcker had crossed the span and liked what he saw. He remained a reporter rather than a player on the trading desk until 1957, when he took another step toward real-world practice and joined the Chase Manhattan Bank. Chase Manhattan took its name from Salmon P. Chase, Abraham Lincoln’s treasury secretary during the Civil War, and from the Bank of Manhattan, founded by Aaron Burr, the vice president of the United States who killed the first treasury secretary, Alexander Hamilton, in America’s most famous duel.
Unlike at the Fed, where memos crept through the bureaucracy at the speed of a turtle, ideas at Chase Manhattan could accelerate like an express train. Volcker worked in the economics department but gained access to upper management as the secretary of a weekly meeting among senior officers of the bank. His summaries for the group raised his profile in the executive suite, exposure that ultimately brought a call from George Champion, president of the bank.
Champion, who had joined Chase in 1933, asked Volcker to come by to discuss his most recent memo. Champion must have liked what he heard, because he said, “Sit down a minute. I’m worried about our [international] trade position. It seems to me we are getting less competitive, and it could affect the dollar. What do you think?”30
Volcker had not thought much about foreign trade since listening to Harvard specialist in international economics Gottfried Haberler describe the intricacies of foreign exchange and the balance of payments. Volcker began to dust off his class notes, eager to apply what he had learned.
But he never got the chance. Robert Roosa had other plans for him.
After narrowly defeating Richard Nixon in the 1960 presidential race, John F. Kennedy identified Cuba and the balance of payments as the two most difficult problems confronting America.31 Cuba made sense. Back then, some fanatics resisted writing with red ink to avoid a hint of Communist sympathy. But aside from a few financiers and professors, almost no one cared about the balance of payments. Robert Roosa, by then a senior vice president at the Federal Reserve Bank of New York, was one of the few. He also knew enough to help.
Paul Samuelson, the Nobel laureate MIT economist who educated millions of Americans with his basic textbook and dazzled his colleagues with wit and mathematics, advised Kennedy on his major economics appointments. He recommended Roosa to the president-elect for the key position as undersecretary of the treasury for monetary affairs.32 Roosa’s job was to fix the balance-of-payments problem.
What was Kennedy worried about? Less than two weeks before the 1960 election, the New York Times ran a front-page headline that got everyone’s attention like a thunderclap: “Kennedy Pledges He Will Maintain Value of Dollar.”33 Until then, most Americans did not realize that the dollar was in any kind of danger, but Kennedy’s promise touched a nerve. No one wanted a decline in the value of the dollar. A few days later the Republicans added a similar assurance.34 Suddenly everyone worried.
Kennedy’s promise meant that the United States would continue to redeem U.S. dollars in gold at the rate of thirty-five dollars per ounce. The pledge applied to foreign central banks that held dollars they received from exporters shipping goods across the Atlantic—the French, who sent wine; the Italians, who sent cheese; and most of all, the Germans, who sent Volkswagens. Americans had not been entitled to redeem their own dollars in gold since 1933, when Franklin Delano Roosevelt made it illegal for U.S. citizens to hold gold, other than as jewelry.
America’s promise to redeem dollars at the rate of thirty-five dollars per ounce of gold was the cornerstone of the world’s payments system. The U.S. commitment, along with the system of fixed exchange rates among the world’s currencies, under the supervision of the International Monetary Fund, had emerged from a three-week meeting, in July 1944, in Bretton Woods, New Hampshire. The Bretton Woods Agreement served as the Magna Carta of international finance for a quarter of a century, until August 1971.
In Volcker’s view, the Bretton Woods Agreement was conceived in a “burst of intellectual energy” that has never “been seen before or since.”35 A month after D-day, the Allied landing in Normandy, France, on June 6, 1944, President Franklin D. Roosevelt invited delegates of the Allied countries to the conference that would design the postwar monetary and financial environment. Roosevelt was aware that much bloodshed remained, but he insisted that “even while the war for liberation is at its peak … representatives of free men should [plan] … for an enduring program of future economic cooperation.”36 Roosevelt believed that “economic diseases are highly communicable,” and international trade was an antidote to world conflict, a vaccination against another world war. He said, “Commerce is the lifeblood of a free society.”37
U.S. treasury secretary Henry Morgenthau headed the American delegation to the conference. On July 1, 1944, he arrived in Bretton Woods, a sleepy village in the White Mountains, noted until then as a refuge for hay fever sufferers rather than as a gathering place for world financiers. He had left a sweltering Washington, D.C., and his first thought upon breathing the crisp mountain air was that he should have packed woolen socks.38 He was joined at the Mount Washington Hotel conference center by more than seven hundred representatives from forty-four countries, including sixteen ministers of finance and central bankers.39
The American group included the then-chairman of the Federal Reserve Board, Marriner Eccles, and highlighted powerful politicians: Dean Acheson, an assistant secretary of state, and Robert F. Wagner, chairman of the Senate Banking Committee. The famed British economist John Maynard Keynes—author of the most influential economic treatise of the twentieth century, The General Theory of Employment, Interest and Money, which created the “Keynesian School” of economics—led the delegation from the United Kingdom, and he was joined by other members of British academic aristocracy: Dennis Robertson, professor of political economy at Cambridge, and Lionel Robbins, professor at the London School of Economics.
Most of the countries represented at Bretton Woods followed the American and British recipes: politicians for power with a sprinkling of academics for flavor. Absent from the conference were representatives of the Axis powers (Germany, Japan, and Italy) and neutral countries, most notably, Switzerland, home of powerful international banks and foreign currency speculators. Argentina was excluded because its “continuing support of the Axis” rendered it unfit to “to sit down with the United Nations in important war and postwar conferences.”40 The conference in New Hampshire was an Allied operation, just like the invasion of Normandy.
The Bretton Woods Agreement was the brainchild of John Maynard Keynes and Harry Dexter White, a U.S. Treasury economist serving as the only technical expert in the American delegation.41 The objective was to restore the golden age of international trade that had flourished for a generation prior to the outbreak of World War I. Most countries adhered to the gold standard before 1914, protecting citizens against inflation by promising to redeem paper currency in gold. The gold content of each currency also fixed the rate of exchange among different currencies: Americans could always get one British pound for $4.86 and could always exchange one dollar for five French francs. As a result, a company such as John Deere, headquartered in Moline, Illinois, knew how much it would earn in dollars whether it shipped tractors to Liverpool, Marseilles, or Kansas City. The absence of fluctuating exchange rates made international trade no more complicated than a visit to the flea market on the other side of town.
The problem with resurrecting the gold standard after World War II was that America had almost all the gold—$20 billion worth buried in Fort Knox.42 No country could credibly promise to redeem its currency in gold except for the United States. The Bretton Woods Agreement anchored the international payments system on America’s hoard, tethered by the U.S. pledge to exchange dollars for gold at the rate of $35 per ounce, with every other country agreeing to fix its currency relative to the dollar. Fixing exchange rates to the dollar required a commitment by central bankers to buy and sell currencies at the agreed-upon rate. Success meant the Bretton Woods System would mimic the stability of the gold standard.
Fixed exchange rates under the Bretton Woods Agreement would also avoid the trade wars of the Great Depression, when countries fought among themselves to devalue their currencies to promote exports. The “butter battle” between New Zealand and Denmark demonstrates the futility of competitive devaluations.43 New Zealand started the fight by devaluing its currency in 1930 to lower the effective price of its butter exports to England, hoping to sell more to cost-conscious Londoners. Denmark retaliated with its own devaluation to neutralize New Zealand’s advantage. The process continued until 1933 and left each country’s total butter exports exactly where they had started. Competitive devaluations made British consumers happy because they paid less for their butter, but no one else benefited, except perhaps the foreign exchange speculators in Switzerland.
The Bretton Woods System of fixed exchange rates would pit governments, and their central bankers, against speculators in a war that lasted a generation. Central banks tried to tame the forces of supply and demand to keep exchange rates fixed, while speculators did their best to make money by anticipating central bank failure to prevent devaluation. Speculators would sell weak currencies hoping to buy them back after they declined in value. In one of the early skirmishes, British officials blamed “the gnomes of Zurich” for mounting “speculative attacks against sterling.”44 Gnomes are imaginary, but speculators are not.
By 1960, speculators scared everyone, including candidates for the most powerful position on earth, the American presidency. JFK affirmed America’s pledge to redeem U.S. dollars in gold in October of that year, in response to speculator attacks on America’s credibility.
Speculators look like normal people, except they smoke big fat Cuban cigars. They try to buy something (anything) in anticipation of selling at a profit after the price goes up. Or they sell first and try to buy later at a lower price. Some speculators focus on stocks, others on bonds, and still others on Super Bowl tickets. (Ticket scalpers are speculators by another name.)
In October 1960, gold speculators tested America’s promise to keep the price of the precious metal at thirty-five dollars per ounce. Transactions among dealers in gold bullion had taken place since March 22, 1954, in the London headquarters of the 150-year-old private banking firm N. M. Rothschild and Sons.45 The free-market price, sometimes referred to as the London gold fixing, was established every day in an auction conducted by the dealers gathered in the boardroom under the gaze of eighteenth-century Rothschild portraits hanging on the wood-paneled walls.46 The price was “fixed” to balance demand for bullion with supply, with orders transmitted to the dealers from investors, gold mines, and central banks throughout the world.
The U.S. Treasury had maintained the price in the London fixing within a few cents of thirty-five dollars by selling gold if excess demand prevailed at that price and by buying if there was excess supply. On October 20, 1960, two weeks before the presidential election, speculators suspected that America might abandon its commitment to sell gold in the free market. They flooded the London dealers with buy orders and, much to everyone’s surprise (except the speculators), the price jumped to levels that had never been seen before.47
Paul Volcker sat in his office at Chase Manhattan Bank on that explosive day in October. During the previous two days, he had watched the price poke above $35.08, the exact level at which the U.S. Treasury promised to deliver gold.48 Paul recognized the danger to American credibility. Prices had always bounced off the ceiling as private groups— mining companies and foreign banks—sold gold, confident that the U.S. Treasury would hold the line. These private sellers, in fact, kept a lid on the price without the Treasury having to sell gold.
A colleague stuck his head into Volcker’s office, looking as though he had glimpsed the hereafter, and said, “The gold price is forty dollars.” Paul stared at his ashen-faced friend. “That can’t be, you mean thirty-five dollars and forty cents.”49 Volcker thought that even $35.40 would be a terrible blow to American prestige, proof that the United States had failed to meet its obligations. And then they checked the news ticker. Speculative purchases on October 20, 1960, had, in fact, driven the price of gold to $40.00 per ounce, an unprecedented number at the time.
Roosa had tutored Volcker, and everyone passing through the New York Fed, that America’s pledge to gold ranked alongside the pursuit of happiness for all citizens, and he had advised the Kennedy campaign to issue the promise not to devalue.50 Newspaper reports identified the source of the speculative buying. “Most of the demand came from the Continent and particularly from Zurich … Swiss bankers have advised their foreign customers to buy gold for deposit there.”51 These reports were denied as total fabrications by the mythical dwarflike creatures, the gnomes, evidently living in Zurich, guarding their new treasure. But gnomes and speculators cannot be trusted.
The jump in the price of gold from thirty-five dollars to forty dollars meant that the dollar had depreciated against gold—technically called devaluation. It would now take an extra five dollars to purchase an ounce of the precious metal. Editors at the New York Times admonished the public with a message worthy of Jeremiah’s Book of Lamentations. “We would all do well to think seriously about the warning we have been given by the London gold market.”52
Robert Triffin, an expert in international trade from Yale, advocated a criminal indictment of America. “A devaluation of the dollar … would be … a wanton crime against the people of this country, and against the friendly nations who have long accepted our financial leadership and placed their trust in the United States dollar.”53
And Richard Nixon, battling JFK for the presidency, piled on in a gang tackle. “The United States cannot afford a debasement of our currency.”54 To all parties involved, what was at stake was nothing less than the stability of the relatively new global financial system.
Volcker believed that America had a moral obligation to uphold its commitment to Bretton Woods and to maintain “the sanctity of the $35 gold price.”55 But he also thought the consequences of devaluation extended beyond ethics. The rumor was that Joseph P. Kennedy, JFK’s father, had told his son, “A nation was only as strong as the value of its currency.”56 Perhaps that is why JFK half humorously listed military power behind a strong currency as a determinant of international prestige: “Britain has nuclear weapons, but the pound is weak, so everyone pushes [Britain] around.”57
Volcker also recalled a comment from Chase’s president, George Champion, about a Southeast Asian country he had visited: “It has a strong currency … so it’s a country we can trust.”58 These sweeping generalizations, linking a country’s currency and its stature, nestled comfortably in Volcker’s brain beside the lessons he had learned from economic history: before 1914, Britain ruled the world with the pound sterling.
Volcker applauded Kennedy’s pledge to maintain the price of gold at thirty-five dollars per ounce. But he knew that simply saying so would not stop the speculators. Oskar Morgenstern had taught him that economists probably knew nothing, or maybe even less than nothing, with one big exception: supply and demand, not words, determine price. Speculator buying (demand) had driven up the price of gold, and would continue to drive up the price further, as long as speculators doubted America’s commitment to supply unlimited amounts of gold to the free market at thirty-five dollars an ounce. Volcker knew exactly what fed the doubts that had led to the buying frenzy on October 20, 1960: America’s weak balance of payments.
Speculators examine the balance of payments the way bookies review the racing form. The balance of payments is a record of a country’s imports and exports. It also determines the supply and demand for a currency in the foreign exchange market. When Americans import Japanese TV sets or German radios, they offer dollars in exchange for foreign currency to pay for their purchases. When the Germans and the Japanese buy American airplanes or invest on the New York Stock Exchange, they offer their currency in exchange for dollars to pay for their purchases. A deficit in America’s balance of payments means U.S. demand for Sony TVs and Blaupunkt radios exceeds Japanese and German demand for Boeing aircraft and General Electric stock, with a corresponding buildup of dollars abroad.
A balance-of-payments deficit predicted trouble.
America was the proud owner of $19.5 billion in gold in December 1959, just about the same amount it had fourteen years earlier, at the end of 1945.59 Less than nine months later, however, in September 1960, a month before the speculative outburst, the U.S. gold stock had declined by almost a billion dollars, to $18.7 billion.60 The Wall Street Journal put the drop for the week ending September 21, 1960, into perspective with the headline “Largest Regular Weekly Decline Since 1931.”61 The Journal explained the root cause as “the continuing deficit in this country’s balance of payments with the rest of the world.”62 Foreigners had more dollars than they needed, so the central banks of Europe and Asia sent their surplus greenbacks to the U.S. Treasury with a polite but firm request to exchange their dollars for gold, as was their right under the Bretton Woods System.
Prospects for a Kennedy victory over Richard Nixon fanned speculator worries about America’s balance of payments. According to the press, European central bankers attributed the flurry of gold speculation to expectations that “Senator Kennedy will win the U.S. election … [and] that a Kennedy election will mean renewed U.S. inflation.”63 Inflation means higher prices, making U.S. products less competitive abroad and leading to fewer exports, worsening America’s balance of payments. Speculators were not merely speculating when it came to Kennedy’s economic policy; his advisers supported greater inflation to achieve another goal: full employment.
Paul Samuelson was John F. Kennedy’s tutor in Keynesian economics, and he had just coauthored an article with his MIT colleague Robert Solow (a future Nobel Prize winner, just like Samuelson), explaining that a country could reduce unemployment if it tolerated an increase in inflation.64 The trade-off between inflation and unemployment was the guiding principle of mainstream economics for nearly a generation. This doctrine would later come under attack from Milton Friedman, founder of the “monetarist school,” and would be blamed for accelerating inflation almost beyond control. But in 1960, Samuelson’s opinion defined the mainstream, certainly for the young presidential candidate.
After the election, when Samuelson touted Roosa with high praise for the job as undersecretary of the treasury for monetary affairs, Kennedy, who at that time was still looking to fill the position of secretary, finally said, “If this fellow is so good, why don’t we give him the top job?”65 Samuelson answered, “You can’t do that. He is too young.” Samuelson’s response entertained Kennedy, who noted that Roosa was only a year younger than he, but Kennedy took the advice.66
The outlook for inflation had emboldened the gold speculators, forcing JFK to pledge fealty to the value of the dollar. He appointed Roosa to the crucial position at the Treasury to help calm the markets. Roosa’s anti-inflationary credentials, honed at the Federal Reserve Bank of New York, matched his commitment to America’s obligations under Bretton Woods.
Ironically, Roosa would battle Samuelson’s allies at the President’s Council of Economic Advisers (CEA) who wanted to promote full employment with a dollop of inflation. Volcker, at the time working for Roosa as an economist, recalls, “At the Treasury we had two main enemies: a State department that did not want the balance of payments to influence foreign policy and a CEA that did not want it to interfere with domestic policy. We had very little room to maneuver.”67
The Council of Economic Advisers, located in the Executive Office Building next door to the White House, consists of three members appointed by the president, plus a staff of about twenty economists on leave from academic posts. Future Nobel Prize winners decorated the CEA during those years, including James Tobin of Yale, Kenneth Arrow of Stanford, and Robert Solow, Samuelson’s colleague from MIT. These economists believed they could engineer full employment just as physicists believed they could put a man on the moon.
Roosa arranged a presidential appointment for Volcker as deputy undersecretary of the treasury for monetary affairs so that he could serve as Treasury’s point man in confronting the CEA.68 Volcker felt like a rookie in a home-run-hitting contest against the 1927 Yankees, and relied on Morgenstern skepticism as his Louisville Slugger.
Volcker recalls: “It all sounded too easy. Push this button twice and out pops full employment. Equations do not work as well on people as they do on rockets. I remember sitting in class at Harvard listening to [the fiscal policy expert] Arthur Smithies say, ‘A little inflation is good for the economy.’ And all I can remember after that was a word flashing in my brain like a yellow caution sign: ‘Bullshit.’ I’m not sure exactly where that came from … but it’s a thought that never left me.”69